Portfolio management is the art of making decisions by blending historical facts with future expectations. Understanding this delicate balance between the known and unknown is an integral part of the investment decision process. In this sense, there are certain events that occur whose true meaning will only become evident with the benefit of hindsight. Fortunately, the stock market is a discounting mechanism and often signals what is going to happen in the future. Unfortunately these important signals are fuzzy and seldom obvious, challenging the astute investor to read between the lines.
One interesting recent development that may have a deeper meaning is the growing list of corporate titans that have seemingly lost their way. Whether it is from management transition issues, product recalls, accounting discrepancies, or questionable corporate ethics, many of these widely held and long respected corporations seem to be floundering. One peculiar case is Wal-Mart, which with its dominant position in retailing has grown earnings per share over the last five years at 13%, outpacing the 1% earnings growth of the S&P 500. Despite this record the company is fighting an intense battle in the court of public opinion surrounding hiring practices, employee benefit policies, and perhaps because they are an easy target as the biggest kid on the block.
I can’t help but wonder if the market is signaling something more profound in this systematic unraveling of some of our corporate icons. Has America itself lost its way?
A leadership transformation… I do believe our society can rise to the occasion and drive innovation and discovery which will ultimately lead to new products, services, and industries. The remarkable potential of nanotechnology, the obvious need for alternative fuel sources, as well as the ever increasing demands for innovative, yet cost-effective health care are all targets of future discovery and market leadership. Monitoring the new discoveries in these areas is important because the next sustainable bull market can not begin without a meaningful leadership theme. My sense is the unraveling of many corporate titans is another stage in a transformation process that will eventually redefine leadership.
Not on my watch… From a portfolio perspective, the trick is to determine which established companies can continue to grow through innovation and by winning the competitive battles within their industry. Others will be challenged to re-invent themselves in order to reinvigorate growth. To those that can produce above average earnings growth the rewards are enormous, as many will not. Yet no corporate CEO wants to admit that the best days of the company they lead are behind them.
A critical aspect of our investment process involves identifying companies that understand that future success will not be achieved by following yesterday’s playbook. Restructuring, layoffs, mergers and acquisitions, all done to lower costs and increase productivity, will no longer ensure competitive success. Corporate America may have already reached the point of decreasing marginal utility on this front. In fact, the market may actually be signaling this as it seems less inclined to pay up for inorganic earnings growth.
A new game plan… Motivating the entrepreneurial spirit within a large organization should be the top priority of corporate leadership. Resistance to change, lack of creativity and an unwillingness to take calculated risks may seal the fate of unwitting corporations. At the same time, large companies that can harness their entrenched competitive advantages within an entrepreneurial corporate culture will have a huge advantage going forward. Corporations dominated by bureaucratic cultures will die a slow death.
A Mount St. Helens market… I have long written about the lack of leadership in the market which remains stuck in a narrow trading range. But like Mount St. Helens, what is visible on the surface often masks the potential changes lurking below. In the investment business those who anticipate change or at least react to it quickly usually win.
So when will this new leadership emerge?... Most likely when investors least expect it. Which is exactly why paying close attention to the signals of the market are so vitally important. Rest assured that is one thing we spend a lot of time doing.
